Why the Midwest surge spikes new home sales in April

The U.S. Census Bureau released the New Home Sales report for the month of April, 2014 on Friday, May 23. New home sales for the month of April, came in ahead of market expectations at 433,000 units. The level was up 6.4% over March, but 4.2% below April, 2013. Annual comparisons for home sales this year, have been adversely impacted by a combination of higher interest rates, higher home prices, and the effect of a severe winter, which has kept buyers indoors during the first three months of the year.

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What are new home sales?

This indicator records the sale of newly constructed homes within the U.S. The headline number is “New Home Sales” which is issued on a Seasonally-Adjusted Annual Rate (or SAAR) basis. The SAAR is the seasonally-adjusted monthly value times 12. The benefit of the annual rate is that one monthly estimate can be compared with another, but monthly data can also be compared with an annual total. The seasonally adjusted annual rate is neither a forecast nor a projection. It is a description of the rate of building permits, housing starts, housing completions, or new home sales in the particular month for which they are calculated.

New home sales make up about 7% of the total residential housing market and are one of the most important housing indicators. Since they’re recorded when contracts are signed, they’re also leading indicators that provide a sense of emerging housing market trends. In contrast, existing home sales are recorded only on closings.

Key takeaways from April’s report

April’s sales figures were helped by lower home prices and a spring surge following an unusually severe winter that kept homebuyers at bay. The median price for new homes fell 2.1% and 1.3%, month-over-month (or MoM) and year-over-year (or YoY) respectively, to $275,800. Sales in the Midwest increased in April, recording an increase of 47.4% MoM. This might be an unsustainable trend that represents a pent-up demand from the winter months. Although sales in the South, the largest region, increased by 3%, the trend has been inconsistent this year and can’t be taken as an improvement in the overall market.

Supply of new homes still a concern: Opportunity for homebuilders

New home sales inventory was almost the same in April at 192,000 new homes representing 5.3 months’ supply—down from 5.6 months in March. Lower inventories and higher demand would benefit homebuilders, all else equal. Homebuilders also have the opportunity to benefit from increased demand that may result from an improving economy and labor market.

Potential homebuyers can also take advantage of lower interest rates before monetary tightening commences and they move up to pre-recession levels. The Fed has already tapered asset purchases by $40 billion per month, since December, 2013. Monetary tightening (for example, an increase in the Fed funds rate) is expected to commence sometime between second and forth quarters of 2015. This factor is likely to increase interest rates across the credit and maturity spectrum, including mortgage rates.

Investor impact

The better-than-expected new home sales numbers spurred the S&P 500 Index to a new record—the Index breached the 1900 level for the first time, closing at 1900.53 on May 23. The price of the State Street SPDR S&P 500 ETF (SPY), which tracks the S&P 500 Index, increased by 0.4% on the same date. SPY also includes investments in homebuilders like Lennar (LEN) and PulteGroup (PHM).

Treasury yields also decreased, causing bond prices to increase. This was due to concerns that the Fed’s projections for economic growth were over-optimistic and that the extent of the rate hike, when monetary tightening commenced, would be more muted. 30-Year U.S. Treasury yields declined by three basis points to 3.40%. Prices of fixed income ETFs increased.

The price of the iShares 20+ Year Treasury Bond ETF (TLT) increased by 0.53% to $112.70 on May 23.

The price of the Vanguard Total Bond Market ETF (BND) increased by 0.1% to $82.13 on May 23.

The next section in this series will discuss the sole labor market indicator released last week—initial jobless claims.